The 10-year yield rose to 5.17%, and expected inflation barely moved

Long-term Treasury yields rose this week by more than the yields that price the Federal Reserve's next move, and almost all of the increase was a higher real yield. The 10-year finished Friday at 5.17%, up 16 basis points. Of that rise, 15 basis points were a higher real yield, the part that remains after inflation compensation. It finished at 2.83%. Inflation compensation, the gap between the two, rose 1 basis point, to 2.34%.

Gramercy, an emerging-markets investment firm, called the week's 10-year the highest since 2007, and the 30-year a peak not seen since 2004.

That split is the question. A higher real yield, with inflation compensation almost flat, is what bonds show when the extra yield is not a higher inflation forecast. A rise led by the 2-year would mean the next rate increase was the thing being repriced.

Against the 10-year's 16 basis point rise, the 2-year rose 5 basis points, to 4.81%. The 30-year rose 15 basis points, to 5.49%. The gap between the 2-year and the 10-year widened by 11 basis points, to 36 basis points. The 3-month yield rose 10 basis points, to 4.24%, already above the 3.75% to 4% range the Fed set on September 16. Bills already yield more than that range. The larger rise was still further out the curve.

Treasurys maturing in more than 20 years, held in BTLT, fell 2.4%. The fund had risen 0.4% in the week of September 14 to 18. Inflation-protected Treasurys, in BTIP, fell 0.7%, which is what a higher real yield does to those prices. Treasurys maturing in one to three years, in BSHY, were flat.

The loss came on Wednesday and Thursday

BTLT rose on Monday. It fell 1.6% on Wednesday and 1.3% on Thursday, and barely moved on Friday.

Wednesday morning, S&P Global's early survey put US manufacturing at 57.0, up from 53.9 in August and above the 53.6 economists had expected. A broader measure of output rose to 58.4 from 56.0, the fastest pace since July 2021. S&P Global said price pressures intensified.

Federal Reserve Governor Michael Barr, who supported the September 16 increase, said more would likely be needed.

"In my base case, further policy adjustments are likely to be needed to ensure inflation comes down to target in a timely fashion."

The Treasury was selling too. It offered $69 billion of two-year notes on Tuesday, $70 billion of five-year notes on Wednesday and $44 billion of seven-year notes on Thursday. The five-year notes sold at a high yield of 5.033%.

Washington Trust Bank said that auction tailed by 3 basis points, a higher yield than the market had shown just before the sale, and that it was the first time the five-year priced above 5% since 2007. The bank said Thursday's seven-year auction tailed by nearly 1 basis point, and that the soft demand pushed yields higher.

Padhraic Garvey, ING's regional head of research for the Americas, and Benjamin Schroeder, its senior rates strategist, called Wednesday's auction the last straw that took the 10-year above 5.1%. They wrote that bond prices already held enough fear of further rate increases to cover the inflation risks they see. They still expect government debt to push longer-term yields higher, and they see that pressure in wider swap spreads around the 10-year, the gap between Treasury yields and swap rates.

On Thursday, before the US open, John Williams, president of the Federal Reserve Bank of New York, described what investors were already forecasting, and called that forecast reasonable if the data allow it.

"It's likely that another rate hike may be appropriate by the end of the year. That seems to me a reasonable way of thinking about it," he said. "But we have to see. We're going to collect the data and do what we did between July and September."

CME FedWatch put the chance of an October increase at 77.5% on Thursday. A separate reading of the same tool on Friday put it at 64%. The 10-year did not reverse with that later reading. It finished at 5.17%, and BTLT barely moved.

Oil rose on the same two days, and inflation compensation did not rise with it. Oil futures, held through BUSO, were higher on Wednesday and Thursday. By Thursday the real yield was 2.85%, 17 basis points above the prior Friday, and inflation compensation was still 2.33%. The ordinary 10-year yield is the sum of those two, so it was higher by the same 17 basis points.

BUSO still lost 3.6% on the week. Through Thursday that loss was less than half a percentage point. Friday accounted for most of it.

Through Thursday the extra yield on high-yield US corporate bonds over Treasurys rose 12 basis points, from 2.68% to 2.80%. On investment-grade bonds it rose 2 basis points, from 0.77% to 0.79%. Beside the rise in Treasurys, that is not a rush out of company debt.

Stocks moved less than bonds

The S&P 500 fund, ASPY, rose 1.3% on the week, and the gain came on Monday, up 1.6%, before the survey. The rest of the week gave a little of it back. On Wednesday, while the long-bond fund was falling, ASPY fell 0.7%. On Thursday it was little changed.

US technology shares, in AXLK, rose 3.5%. Utility shares, in AXLU, moved with the long bond. The fund fell 3.8%.

Saxo, writing on Friday about options prices, said the repricing was in rates, and that equity index volatility had not participated.

In our view a higher real yield, with inflation compensation barely changed, fits a Fed holding inflation down. A quiet 2-year, beside the long end's rise, fits extra yield for lending long. The week did not say which one set the 10-year.